ALCO Meetings (Part 2 of 3 Parts)

Again on a rotating basis, four meeting a year can be used to review model assumptions used in the A/L Benchmarks model. I would further suggest that these meeting be held in January, April, July and October to coincide with data submission which typically occurs in February, May, August and November.

You can find your modeling assumptions beginning on page 53 of the Executive Report under Service Kit Inputs. Although the service kit information is optional, it is good modeling practice to submit as much detailed information as possible.

The first piece of data in addition to the call report is an investment download. We can obtain this information from your bond dealer or you can upload this file yourself. This allows us to model your investments on a Cusip by Cusip basis. It also allows us to capture all of the optionality in the portfolio (call dates, repricing dates, spreads et cetera). Here is a link to the investment data specifications:

The next piece of information that is required is a loan data file. Similar to the investment data file, this allows us to model your loans on a loan by loan basis. Here is a link to the loan data file format options:

It should be pretty obvious that we would like you to send us the data using the #2 or #3 format. These file layouts don't contain any sensitive customer data (like Social Security Numbers, etc.) These formats also provide us with some very informative additional fields. Certainly if you have variable rate loan that are at or approaching floors, we should be capturing this data. If we you are not uploading your loan file using the #2 or #3 format, why not? This is good ALCO discussion.

The next modeling assumption to review is the detailed information on your time deposits. The call report does not break out fixed and variable rate time deposits so this information is needed to accurately calculate the cash flows of these instruments.

Moving along, has the bank enacted a sweep account since the modeling assumptions were last reviewed? If so, we will need the Core Deposit Balances & Expense items. Additional information on core deposits (DDA, NOW, Savings and MMDA) includes the core deposit repricing beta factors and the decay assumptions. These assumptions are used for the earnings simulation (core deposit repricing beta) and EVE simulation (decay assumptions). Your "core" deposit accounts are unique in that 1) they have no contractual maturity and, 2) rates are typically administered; they change when management decides to move the rate. How do these issues affect your model?

Let's look at the core deposit repricing beta factors first. In English this means, for every 100 basis point movement in Fed Funds, what is the corresponding movement in your Now, Savings and Money Market rates? Is it 10%, 50% or 100%? A good analysis would look at a recent time period, for example 1/30/08 to 4/30/08 or 4/30 08 to 10/29/08, where Fed Funds moved 100 basis points (downward). Next look at your deposit rates for those same time periods and calculate the percentage movement.

The decay assumptions looks at the behavior of these deposits in terms of maturity. The accounts don't actually mature, but what is the average life of these deposits? You have four modeling options for decay assumptions. The first option was proposed by FDICIA (305) back in the early 90's but never adopted. These decay assumptions are rather "short", meaning, the assumption is that these core deposits are in the bank for a shorter time frame, typically with a duration of approximately -1.7 years. The OTS uses a decay formula (technically not a decay assumption) that takes into account the current rate paid on these deposits. The OTS decay formula tends to be a bit longer in terms of duration, -2.0 years or more. The bank can hire an independent outside party to conduct a core deposit study at a cost of approximately $8000-10,000. (The cost tends to eliminate this choice pretty quickly!) Finally, you can conduct your own internal study by collecting data from all closed account by category that includes the open date, closed data and average balance. You would need to collect at least 1-2 years of data to begin your study with 5 years of historical data being optimal. From this closed account data, we can provide custom decay assumptions, typically reviewed annually for accuracy.

The banking industry is relying more and more on the FHLB to provide sources of funding. It is important to provide detailed data, including call or put options, on each of your FHLB advances in order to accurately model their projected expenses and cash flows:

Other Supplemental Data up for review includes Unusual Non-Interest Income and Expenses, useful in determining the overhead piece of the Present Value Calculation. Non-interest income and Expenses that can be classified as unusual or non-reoccurring can be backed out of the operating expense component of the discount rate calculation. Supplying the Common Shares Outstanding allows us to calculate an earnings per share ratio and the State Tax Rate insures accuracy in calculating the appropriate taxes in the forecast.

Repo information is combined on the call report with overnight Fed Funds. Pricing and maturity structure can vary dramatically so for accuracy, it is important to isolate Repos from Fed Funds. Additionally, it is important to supply the prepayment speeds for Residential and Multi-Family real estate loans. Has this changed dramatically in the current rate environment? When was the last time the prepayment speed was reviewed?

The final and most comprehensive assumption that you should be reviewing is the forecast of the balance sheet, new pricing rates and non-interest income and expense items. Often the bank's budget is scrutinized and then cast in stone for the year. We know, however, that the budget is actually much more dynamic than that. At least quarterly, ALCO should review current balance sheet targets, pricing decisions and non-interest and expense items and adjust as necessary.

Again, these assumptions should be reviewed by ALCO quarterly, prior to data submission. Please do not hesitate to call your Analyst if you have any questions on modeling assumptions or have a unique situation that is not addressed in any of the outlined input formats.